Wisdomtree: Case For The Chinese Yuan

CYB

The Case for the Chinese Yuan

Investors may look back at the liquidity crisis of 2008 as the inflection point that affirmed China as a global economic superpower. During this time, the majority of emerging market currencies suffered as investors fled higher-risk currencies. However, the Chinese yuan largely tracked the safe haven flight to the U.S. dollar, and investments providing exposure to movement in the yuan generated a positive return and exhibited low volatility during the most volatile market environment in recent history.

Chinese Yuan Forwards vs. S&P 500 Index (October 1, 2007–September 30, 2009) 20 10 0 -10 -20

7

/0

30

/ 12

8

/0

30

3/

8

/0

30

6/

8

/0

30

9/

8

/0

30

/ 12

9

/0

30

3/

9

/0

30

6/

9

/0

30

9/

-30 -40 -50 -60

JPMorgan ELMI+ Chinese Yuan Subindex Cumulative Total Return on S&P 500

Sources: JPMorgan, Bloomberg 2009 Past performance does not guarantee future results.

Strictly regulated by Chinese authorities, the Chinese yuan is managed to trade in a tight range relative to a basket of currencies, including the U.S. dollar. Because the Chinese government has emphasized stability in the currency, changes in the yuan’s value relative to the dollar have tended to be implemented in a slow and deliberate fashion. Since the currency was allowed to float from its peg to the dollar in 2005, the pace of appreciation relative to the dollar had been relatively consistent until last summer, when a closer relationship to the dollar emerged.

Several factors, however, could cause the yuan to further appreciate relative to the dollar in the coming years: + Long-term growth potential relative to the developed-market countries, particularly the U.S. + Increasing role as a global economic leader + Attempts to diversify away from the dollar + Relative undervaluation given China’s economic development

Average Annual Total Returns (October 1, 1999–September 30, 2009) 1-Year Return JPMorgan ELMI+ China S&P 500 Index

5-Year Return

10-Year Return

4.94%

4.08%

3.98%

-6.91%

1.02%

-0.15%

Sources: JPMorgan, Bloomberg You cannot invest directly in an index. Past performance does not guarantee future results. The JPMorgan Emerging Local Markets Index Plus (ELMI+) China subindex uses a weighted basket of 1-, 2- and 3-month currency forwards collateralized with U.S. money market rates to proxy the total returns of local-currency money market instruments in China. A forward contract is an agreement by two parties to transact in currencies at a specific rate on a future date. The S&P 500 Index is a cap-weighted index of 500 stocks, designed to proxy the performance of leading industries in the U.S.

CYB: WisdomTree Dreyfus Chinese Yuan Fund

CYB: WisdomTree Dreyfus Chinese Yuan Fund

Each of these factors points to the likelihood of the eventual liberalization of China’s foreign exchange regime, and the potential for meaningful appreciation in the yuan relative to the U.S. dollar. + Long-term growth potential—Fostered by fiscal stimulus, industrial production and economic growth, China remained resilient during the financial crisis of 2008 and 2009, while developed market economies suffered. Economic statistics suggest continuing momentum within the Chinese economy:

Annual Percentage Change in Real GDP* (estimates start in 2009) 25%

Euro Area United Kingdom United States

20% 15%

Japan China

10% 5%

14 20

12 20

20

10

08 20

06 20

04 20

02 20

00

98

20

-5%

19

19

96

0%

-10%

Source: IMF World Economic Outlook and Update, 2009

Industrial Production Year-over-Year Change (September 1999–September 2009) 35%

China Value Added of Industry United States

30% 25% 20% 15% 10% 5% 0% -10%

06

05

04

9/

9/

9/

9/

9/

9/

9/

03

02

01

00

-5%

07

9/

08

9/

09

9/

-15%

Source: Bloomberg 2009

U.S. Dollars (In Millions)

China: Foreign Exchange Reserves (October 1, 1999–September 30, 2009) 2500000

$2.3 Trillion (29.6%)

China held 29.6% of global foreign exchange reserves as of 9/09

2000000 1500000 1000000 $515 Billion (14.5%)

500000 0

9/00

9/01

9/02

9/03

9/04

9/05

9/06

9/07

9/08

9/09

Source: Bloomberg 2009

+ Increasing role as a global economic leader—China has become a leading advocate of a global reserve currency and reduced dependency on the U.S. dollar. Regionally, China is playing an increasing role in the Pacific Rim, facilitating agreements with Korea and Japan to provide foreign exchange liquidity to Korea during the crisis. With international reserves exceeding $2 trillion, China will likely play a role in any major global capital market or economic development.

*Real GDP is gross domestic product in constant dollars. It is a nation’s total output of goods and services, adjusted for price changes.

CYB: WisdomTree Dreyfus Chinese Yuan Fund

+ Attempts to diversify away from the dollar—In 2009, China initiated a pilot program with Hong Kong companies to settle trades in yuan and has since pursued similar arrangements with Brazil, Russia and Korea. Trade settlement will facilitate crossborder transactions and increase pressure to liberalize the currency. Additionally, the government is looking to issue its first yuan-denominated government bond to Hong Kong investors. China’s enormous consumption of commodities increases its sensitivity to the value of the U.S. dollar, since commodities are typically priced in dollars. The currency weakness of commodity-producing nations during the crisis created opportunities for China to make direct investments into commodity producers and secure long-term sources of supply outside the U.S. dollar. + Gradual transition to a domestic-driven economy—As China makes the transition from an export-driven to a domesticdemand-driven economy, we believe sensitivity to yuan appreciation will eventually subside and actually become a positive as the country imports more goods. Additionally, the younger generations in China consume at a much higher rate than the older generations, or many of their peers across Asia, suggesting that a sizable drop in the current savings rate could occur in future years. + Relative undervaluation given its economic development—The currencies of emerging market countries are often valued at a discount to their long-term purchasing power, given uncertainties related to investing or conducting business in an emerging nation. However, as China becomes more fully integrated into the global economy, this discount could begin to dissipate and the value of its currency could eventually converge with its long-term purchasing power. This is even more likely given the widely held view that the appreciation of China’s currency has been restrained in order to foster its exports. According to recent estimates of purchasing-power parity from the World Bank, the Chinese yuan would need to rise 76% to achieve parity levels.

58%

65%

67% Denmark

35% Australia

Norway

33%

Switzerland

30% Japan

Sweden

12% Canada

25%

12% New Zealand

7% UK

Europe

-15% Brazil

0% -18% Czech Republic

-4%

-23% Singapore

Israel

-24%

United States

-27% Turkey

-29% Romania

Hungary

-30%

-37%

-32%

-37%

Russia

Poland

-40% Chile

Saudi Arabia

Hong Kong

-40% Mexico

-33%

-41% Indonesia

Korea

-43% China

-35%

-46%

-36%

-47% Peru

Taiwan

Colombia

-47% Argentina

South Africa

-50%

India -66%

100 80 60 40 20 0 -20 -40 -60 -80 -100

Thailand

Discount/Premium of Current Exchange Rate to PPP

Valuation Relative to Purchasing-Power Parity (Using exchange rates as of September 30, 2009)

Source: Bloomberg, World Bank, WisdomTree 2009 The purchasing-power-parity rate (PPP) between two countries is the rate at which the currency of one country needs to be converted into that of a second country to ensure that a given amount of the first country’s currency will purchase the same volume of goods and services in the second country as it does in the first. In the WEO online database, it is expressed as local currency per U.S. dollar. The discount or premium to PPP is the ratio of the current spot (expressed in dollars per foreign unit of currency) relative to PPP (expressed in dollars per unit of foreign currency).

Downside Risks Political unrest and the failure of monetary authorities to prudently remove excess liquidity pose the principal risks to the underlying value of the Chinese yuan. A significant decline in asset values from current levels could also expose a bad-debt problem created by the recent surge in lending. We believe the current level of the yuan relative to its long-term potential provides downside risk protection, and the sizable reserve base offers the government sufficient ammunition to defend the currency if needed.

Your Exposure to the Chinese Yuan

For the first time, investors can gain exposure to the Chinese yuan in an ETF. CYB, the WisdomTree Dreyfus Chinese Yuan Fund, seeks to achieve total returns reflective of money market rates in China available to foreign investors as well as changes in value of the Chinese yuan relative to the U.S. dollar. Since direct currency investments into China are not available to foreigners, the ETF combines U.S. cash investments in a one-to-one ratio with forward contracts to provide the desired exposure to the Chinese yuan. The ETF largely restricts its investment in U.S. money markets to government securities and repurchase agreements collateralized by government securities. Daily trading volume in the yuan/dollar foreign exchange instruments offshore exceeds $3 billion in notional value. (Source: HSBC Guide to Emerging Market Currencies 2008.) Although this Fund invests in very shortterm, investment-grade instruments, the Fund is not a “money market” fund, and it is not the objective of the Fund to maintain a constant share price. Expense Ratio: 0.45%

CYB may be appropriate for investors seeking: + A low correlating/alternative asset class for diversification + Access to the potential of China without equity risk + An inexpensive,* flexible tool for investing cash around the world without size, time or margin constraints

Learn more

about CYB and the entire family of currency income ETFs at www.wisdomtree.com

*Ordinary brokerage commissions apply. Correlation is a statistical measure of how an index moves in relation to another index or model portfolio. A correlation ranges from –1 to 1. A correlation of 1 means the two indexes have moved in lockstep with each other. A correlation of –1 means the two indexes have moved in exactly the opposite direction. Diversification does not eliminate the risk of experiencing investment losses.

Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. To obtain a prospectus containing this and other important information, please call 866.909.WISE (9473) or visit wisdomtree.com. Read the prospectus carefully before you invest. Past performance does not guarantee future results. There are risks associated with investing, including possible loss of principal. In addition to the normal risks of investing, foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. The Fund focuses its investments in specific regions or countries, thereby increasing the impact of events and developments associated with that region or country, which can adversely affect performance. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than developed markets. Investments in currency involve additional special risks such as credit risk, interest-rate fluctuations and derivative investment risk which can be volatile and may be less liquid than other securities and the effect of varied economic conditions. As this Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers. Unlike typical exchange-traded funds, there is no index that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile. WisdomTree Funds are distributed by ALPS Distributors, Inc.

Please call 866.909.WISE (9473) or visit www.wisdomtree.com for more information. © 2009 WisdomTree Investments, Inc. “WisdomTree” is a service mark of WisdomTree Investments, Inc.

WIS002162 (11/2010)